Federal Fiscal Court on free heat supplies which must be treated as made for consideration

Facts of the case

The operator of a combined heat and power plant, which fed the electricity generated into the public grid for a fee, supplied the heat generated free of charge to an asparagus farmer to heat the asparagus fields, and to another entrepreneur to dry wood. A dispute arose regarding the question of whether the operator had to pay VAT on a free transfer which must be treated as made for consideration in this respect and how the basis of assessment was to be determined in this case.

BFH decision

The BFH had initially referred this case to the ECJ for a preliminary ruling, decision of 22 November 2022, XI R 17/20, decided by the ECJ ruling of 25 April 2024, C-207/23, Finanzamt X v. Y-KG. This was necessary because the ECJ decision "Mitteldeutsche Hartstein-Industrie" (C-528/19, 16 December 2020), which also concerned a potential free transfer that must be treated as made for consideration, left some questions unanswered from the BFH's point of view. We present selected considerations of the BFH and the core elements of the ECJ decision here.

Untaxed final consumption as an additional requirement?

In the "Mitteldeutsche Hartsteinindustrie" decision, the operator of a quarry had upgraded a municipal road so that it could accommodate the quarry's heavy goods traffic without receiving any remuneration from the municipality. In this case, the ECJ had denied a free transfer that must be treated as made for consideration. In its reasoning, it referred to the fact that there was no untaxed final consumption, as the road had not been developed for use by the municipality, but for use by the quarry operator. The latter carried out taxed output supplies using the road.

In its request for a preliminary ruling dated 22 November 2022, the BFH considered, in contrast to this decision, what possible uses there were for the heat generated in addition to the electricity. While, in the opinion of the ECJ in the "Mitteldeutsche Hartstein-Industrie" decision, a priority use by the taxable person over the (author's note: unavoidable, therefore) "irrelevant" use for public transport would exclude untaxed final consumption, in the case of heat utilisation, it would also be possible, for example, to allow the heat to escape unused or to use it for one's own purposes.

In its decision C-207/23 of 25 April 2024, the ECJ came to the conclusion that an item had been given to the recipients free of charge and that this fulfilled the requirements of a free transfer that must be treated as made for consideration. In contrast to the facts on which the "Mitteldeutsche Hartstein-Industrie" decision was based, in the case of Finanzamt X v. Y-KG, the additional heat produced was not used by Y-KG.

The ECJ only briefly addressed the additional considerations in the BFH's order for reference. In this decision, the BFH also made the following considerations, among others: If the supplier supplies goods to a taxable person against payment, that taxable person deducts the input VAT and VAT neutrality is ensured. If the supplier supplies free of charge, he must pay VAT without the recipient having a corresponding right to deduct input VAT. In this case, it is conceivable that an invoice could be issued without a request for payment and the input VAT deduction could be granted - an interesting proposed solution.

However, the ECJ replied that a free transfer that must be treated as made for consideration does not depend on whether the recipient is a VAT taxable person authorised to deduct input VAT. An additional condition, according to which the recipient of the free transfer would have to use it for input VAT deductible output transactions, does not arise from the relevant Article 16 of the VAT Directive. Such a requirement would also lead to practical difficulties. The "Mitteldeutsche Hartstein-Industrie" decision is not transferable. In that case, the free transfer was ruled out because the expenses incurred by the supplier also had a direct and immediate connection with his taxed output transactions, which is not the case here.

The BFH agreed with this result.

Costs not charged with input tax/only indirectly attributable costs as part of the tax base?

Moreover, the BFH had asked whether only costs subject to input VAT should be included in the taxable amount. This question was based on the consideration that by taxing the free transfer, a taxable person who behaves like a consumer by making a purchase should be treated in the same way as a consumer. If a taxable person does not use the purchased item for business purposes, he should either have no input VAT deduction, like a consumer, or be taxed the free transfer. If a consumer manufactures an item, he is only charged VAT to the extent that he receives invoices with VAT for his expenditure. This could justify including the costs of a taxable person who manufactures a biogas plant in the assessment basis for the free transfer only to the extent that they were subject to input VAT.

In addition, the BFH considered it necessary to clarify whether indirectly attributable costs, such as financing expenses, should also be included in the assessment basis of the free transfer of value. The ECJ ruled that not only the direct manufacturing and production costs are relevant for the tax base, but also indirectly attributable costs such as financing expenses. It does not matter whether the costs in question are subject to input tax.

In line with this, the BFH initially clarified in its judgement that the cost price should be used as the assessment basis for the free transfer of value, as there was no purchase price for the heat. Although a fictitious purchase price could also be considered, the tax court ruled in an unobjectionable manner that such a price could not be determined on the market, as the operator of the combined heat and power plant was not connected to a public heating network.

The allocation of cost price to electricity and heat should be carried out according to the so-called market value method. The legal concept of § 15 para. 4 UStG (German VAT Code on input VAT apportionment) should be applied. The exclusively energy-based method used by the tax authorities (sec. 2.5 para. 22 sentence 6 UStAE – administrative guidelines to the German VAT Code) is not appropriate. Instead, a two-stage, exclusively turnover-based estimate should be applied without taking into account the unused heat, as the BFH had previously ruled.

The fact that the tax court used sales prices from two district heating providers in the vicinity of the operator of the combined heat and power plant for this estimate was also not objectionable. The tax court correctly made a deduction for the fact that the customers had to bear the costs of installing a pipeline network.

When calculating the cost price, the tax court, in accordance with the ECJ ruling, also rightly took into account costs not directly related to manufacture or production that are not subject to input VAT (e.g. financing costs).

Practical impacts

This decision is not good news for operators of combined heat and power plants. Not only is the free transfer taxable – the judgement also pushes up the assessment basis by including both costs not subject to input VAT and indirect costs. This corresponds to the view of the tax authorities in section 2.5 para. 22 UStAE. However, the energy-based allocation method stipulated there by the BMF is now, finally, no longer tenable. It is also painful that the BFH used the prices of district heating providers when calculating the cost price. The operator of the combined heat and power plant had argued, among other things, that it was necessary to supply heat in order to receive an increased bonus under the Combined Heat and Power Act. It was therefore hardly possible to obtain a fee for the heat generated and a comparison with local municipal utilities was not possible. The operator was not successful with this argument.

Alternative options, such as the agreement of a low consideration, should be examined.